KPMG Strikes Back on Ex-Clients' Tax-Shelter Suits

By LYNNLEY BROWNING

Published: August 18, 2005

CORRECTION APPENDED

The accounting firm KPMG is quietly putting the boxing gloves back on. Even as KPMG is in discussions with federal prosecutors to settle a criminal investigation over its sale of what the Internal Revenue Service says are bogus tax shelters, the firm has been taking on former clients who have sued it over those same shelters.

Among those former clients are two wealthy sons of Robert C. McNair, a Houston oilman and the owner of the Houston Texans of the National Football League. The McNair brothers, R. Cary and D. Calhoun, sued KPMG in a state court in Houston in December 2003, contending that the firm in 1999 knowingly sold them bogus tax shelters.

Last month, KPMG filed an unusual related lawsuit in a state court in Austin against two Texas law firms and a Texas-based investment adviser that the McNair brothers used to evaluate the KPMG tax shelters that each bought.

Such a get-tough approach with investors like the McNairs represents a ''new directed strategy, a big change'' for KPMG, a senior executive involved in the matter acknowledged.

In challenging investors now suing it, KPMG is hoping to prove that its former clients and their personal advisers were at least partly to blame for their woes with the I.R.S., because, according to KPMG, they were sophisticated individuals who knew the risks of buying aggressive tax shelters.

A spokesman for KPMG, George Ledwith, said, ''We look forward to resolving the civil litigation expeditiously, and with full and fair accountability.''

But the senior executive involved put it more bluntly. KPMG, this person said, is ''not going to be solely accountable in a transaction in which others should be also accountable.''

''Look how many lawyers and accountants were also in this,'' the executive added.

A lawyer for the McNairs, Paul J. Dobrowski, criticized KPMG's tough legal tactics, saying: ''They're trying to deflect attention from their own activities. It's very cynical.''

The tax shelters the McNairs bought from KPMG are known as Blips -- for bond-linked issue premium strategy. The shelter involved using partnerships to create artificial losses that were then used to offset taxes due on legitimate income.

The I.R.S., which never considered the shelter valid for deductions, officially banned it in September 2000, when it became better informed about its workings and use. It estimates that at least 1,800 individuals used it or a similar shelter to evade billions in taxes.

In its lawsuit, KPMG says that it wants to know why the McNairs claimed the deductions after being told by a former partner in the firm that the I.R.S. had effectively banned Blips and that the brothers should seek independent accounting and legal advice. The McNairs filed their tax returns with the deductions generated by the shelters in October 2000, a month after the I.R.S.'s effective ban, according to the suit.

Mr. Dobrowski, the McNairs' lawyer, disputed the accuracy of KPMG's chronology, but declined to provide further details.

According to the suit, two Texas law firms -- Andrews Kurth and Holland, Johns, Schwartz & Penny -- advised the McNairs to claim the deductions on their tax returns without disclosing their actual use of the shelter, a violation of I.R.S. rules. Holland, Johns and the investment adviser, the Redstone Companies, advised the McNairs to enter into the transactions after the McNairs turned to them for advice on the propriety of the strategy before buying the shelters, according to the KPMG complaint.

A lawyer for the Redstone Companies, Fields Alexander, said that the suit was without merit and that his client would defend itself vigorously.

Lawyers for KPMG are now seeking to obtain communications and documents detailing how and why the McNairs' outside lawyers, accountants and advisers urged the brothers to participate in an I.R.S. settlement for investors in Blips, according to a court filing. KPMG says the matter is relevant to determining how much money KPMG might pay to settle with former clients like the McNairs.

The McNair brothers' lawyers have argued in court filings that the communications are protected under rules providing for lawyer-client confidentiality. In 2003, KPMG also claimed client confidentiality when the I.R.S. sought to force it to turn over documents related to the creation and sale of questionable tax shelters. The firm later backed down.

In its related lawsuit, KPMG asserts that if it is found liable for any damages to the McNairs, the three firms should help KPMG pay some of the money.

A trial date has not yet been set; the judge assigned to both cases is expected to do so in coming weeks.

At least one tax lawyer not involved in any KPMG case expressed doubt that the firm's strategy of trying to spread the blame would work. ''The whole concept of 'I did wrong, but you were a co-conspirator' is not inconsistent,'' said Geoffrey A. Goodman, a white-collar defense lawyer in Sacramento and a former federal prosecutor, ''but it's going to be mighty hard for an accounting firm to say you had as much knowledge as I did.''

Correction: August 19, 2005, Friday
An article in Business Day yesterday about a Texas lawsuit filed by the KPMG accounting firm against a former client misstated the court location. It was Houston, not Austin.